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Overview
Munich Re (ISIN: DE0008430026) is one of the world’s leading reinsurance companies. It was founded in 1890 and generates today sales of about 51 billion(bn) with a net income of 3bn by the help of 45k employees. Due to the highest dividend yield in the German DAX of about 5% per annum and steady previous dividend increases.

The report is structured as the following:

1. Leadership & Corporate Culture
2. History & Status Quo
3. Sustainable Core Competence
4. Fair Price with Safety Margin
Summary & Key Findings

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Overview
Munich Re (ISIN: DE0008430026) is one of the world’s leading reinsurance companies. The headquarter lies as the name implies in Munich, Germany. Munich Re was founded in 1890 and generates today sales of about 51 billion(bn) € with a net income of 3 bn € by the help of 45 k employees. Due to the highest dividend yield in the German DAX of about 5% per annum and steady previous dividend increases, this company could fit to the investment strategy at Eternal Yield.

1. Leadership & Corporate Culture

• Conservative, discrete board. Long-term human resource planning (esp. C-Suite). CEO worked his whole professional life at Munich Re. Employees seems to be very lucky to work there, highly committed to their employer.
• Employees: 11,300 reinsurance / 29,600 direct insurance / 3,750 Others (mainly Munich Health)
• Insurance premiums (income source): 27.8 bn € (54.4%) reinsurance / 16.7 bn € (32,68%) insurance / 6,6 bn € (12.92%) Others
• Well-regulated working processes. Huge  in- and outcome processes (conclusion of contracts, clearing, notification of claim, damage reports,…) esp. in first insurance.
• Value added chain looks predominantly static except new product production (contracting).
• Extreme specialization in product production / contract design observed: Mathematics for earth quake forecasting, international contracting or assessments of real values (e.g. real estate, IT centres, energy / communication infrastructure, estimation of road / weather / wealth specific loss ratios, …).
• Scientific departments working on estimations of interdependencies between risks.
• Graduates try to get in there, due to the offered high start income and the livable city Munich (large application pool, easy exchange).

Well managed professional administrative machinery with highly specialised core and happy, well paid workforce

2. History & Status Quo

Net income 2013:

• Main income by reinsurance: 2.8 bn €
• Additional income by insurance / others: 0.5 bn € (mostly by subcompany ERGO)

Growth:

• Income growing, but unstable due to compensation payments esp. when wider environmental natural disasters happen.
• Running share buyback program (scope 1 bn in 2014). This shares are held by Munich Re and received dividends are used for management payment.

• 2011 earth quake in Japan and New Zealand, Tornado damages in the US and floods in Australia and Thailand simultaneously, so that the profit drops (focus on net income). Yearly income can be zero.
• Interplay between insured risks important and addressed by contracting.
• 0.23 bn € adding net income per year over the last five years (from linear regression, see graph above). Results in net income growth between 9% and 7% per annum.
• Growth source: Worldwide long-term insurance market growth observed, depending on the worldwide accumulated net worth. Expanding protection need of households, companies and governments with higher wealth and upcoming technology. Through progress of technic new risks occur that have to be insured (e. g. cyber crime).
• All cash flows healthy.

Market environment:

• Oligopoly market structure with five players (receive about 70% of worldwide reinsurance premiums): Munich Re (market leader), Swiss Re, Berkshire Hathaway, Hannover Re and Lloyd’s.
• Market leader position could go with higher pricing power.

Combined Ratio (indicator of profitability for insurance companies):

• Good ratios. Reinsurance highly profitable except in 2011/2010.
• Insurance goes with a less volatile ratio.

Debt:

• Equity ratio stable around 10 %. That corresponds to 25 bn € with a balance sheet total of 250 bn. Heavy debt usage (high leverage usual within banking and insurance sector) implies huge tax shield, but still healthy – top credit ranking & no reasons for taking higher risks from the director’s point of view.
• Minimum equity required as a deposit for insurances referred to Solvency II. Fulfilled by Munich Re.
• High dependence on capital market is a risk factor. Fast rising central rates or upcoming new laws bear risks.

Dividends:

• 7.25 € dividends per share in 2014. Results in 1.27 bn € payout (out of 3.3 bn € net income).
• Payout ratio between 35 % (2014) and 159 % (2011). Usually below 100 % (mostly covered).
• Last 10 years: Stable dividend growth (dividends went up 9x, constant 1x).
• Dividends increased by 13.7 % on average (far above inflation).
• Dividend policy: Board aims to have a sustainable dividend and hold it stable in crucial years as well.
• More than 10 years ago the stock took part at the Dot-com bubble. Prices in 2000 above 350 € and after the crash at the lowest point at 50 €. Still no recovering from this – current price at about 150 €.

Income growing, but  unstable due to insurance of random harm. Second risk factor lies in financial market dependency (e. g. rising central rates, new financial transaction costs,…). Superior income and growth observed.

3. Sustainable Core Competence

• Large scale disasters prediction and their results in insurance losses (catchword – risk management).
• Vertical integration of insurance and reinsurance.
• Economies of scale (highest net premiums af all reinsurance companies).
• ‘Clean’ organization and administration.
• Strong brand build up over 120 years.
• High entry barriers esp. in reinsurance (high financial and human capital for enter needed).

Core competence stands and falls with large-scale disasters prediction and affiliated risk management. Competitive advantage given by market leader position and enables synergy effects through forward integration.

4. Fair Price with Safety Margin

• Key business model: Selling reinsurance contracts to insurance companies, which covers bunches of direct insurance contracts – ‘Insurer of insurance companies’.
• Worldwide diversification through insurances in nearly all countries. Bulk of insurance premiums comes from Europe. Therefore, weak dependencies with single countries and their legislation.
  
• Well known brand. No (extensive) marketing needed.
• Historically highly reliable business partner (worldwide only remaining liquid reinsurance after San Francisco earth quake in 1906).
• Far from end-consumer, B2B, mainly contracts with other insurance companies.
• Need not (directly) included in Maslow’s pyramids lower layers and only emerges with (relatively) high prosperity in order to secure living standards financially.
• Exchange rate risks are not considered here (Check this, if your accounting does not use €).

Derivation of assumptions for Net Present Value ():

• = Required long-term yield of 8%. Corresponds historical long-term stock yields in Europe/US. Plus safety margin, so we use 10%.
• = Eternal dividend growth. Should be in line with long-term net income growth. Period 2009-2013 had 8%. Representative period, with the 2011 income drop. Plus safety margin we get 6% dividend growth.
• = Dividends 2015. 7.25 € dividend per share in 2014. Added safety margin: 2014 dividend assumed for 2015.

Gordon Growth Model:

• Calculation in €
• =10%
• =6%
• =7.25€
• Price at approx. 150 € (8. August 2014 )

With given long-term assumptions (incl. multiple safety margins) this stock is undervalued and could be an interesting long-term investment.

Summary & Key Findings:

• Well managed professional administrative defensive cash-cow company.
• High income, but unstable and sometimes zero due to the insurance of random harm.
• Mostly covered dividends, with above average growth rates.
• Two major risks: Large-scale disasters prediction (risk management) & financial market risks.
• Competitive advantage through its market leader position.
• With given long-term assumptions this stock is undervalued.

Further Interesting Facts:

• Unpopular stock in Germany: Often we read that Munich Re is a ‘boring stock with bond character’. Disregarding the fundamental difference between buying equity and lending, bonds do not have a yield growth ( ).
• Minor physical value – value  largely financial and intangible like know-how.
• More dependent on legislation (compared to other non-financial sectors).
• Most expensive case with assured assets: Earth quake in Tokio city. Would diminish income to zero. Such extreme cases are covered by all insurance companies pro rata worldwide through bilateral contracts.

Further Sources for Evaluation:

Yahoo Finance Sheet
Financial Reports of Munich Re
Global Reinsurance Guide 2014 by Fitch

If you have any suggestions, comments, proposals or others please share your thoughts!